Naked Shorting Targeted By New IIROC Notice

This morning IIROC, who oversees all investment dealers and trading activity on debt and equity markets in Canada, issued a notice effectively aimed at the practice of “naked short selling.” The note states that short sellers without a reasonable expectation that they will have access to sufficient securities to settle any resulting trade on settlement date, which generally is two days following the trade date, is prohibited by UMIR 2.2 – Manipulative and Deceptive Activities.”

Understanding Two Types of Short Sales

In general, there are two ways to describe short sales: “covered” or “naked.”

A covered short sale is when a seller arranges to borrow or acquire the shares when a short sale is made. Conversely, a naked short sale is when a seller has sold shares they do not own, and has made no prior arrangements to borrow or acquire, but hopes to obtain shares to settle the trade.

Our Interpretation of the IIROC Notice

Essentially, our interpretation of IIROC’s notice after speaking with industry insiders is that the note is primarily aimed at those who are attempting to sell shares they have made no prior arrangements for, thus naked short sales.

From our interpretation, short sales:

  • Must have borrow in place.
  • Or if it is a short sale with underlying securities that have a restrictive legend, the legend must be off before the settlement date (or the day of).
  • Or if it is a short sale prior to closing a new issue (i.e., a financing that will see new shares issued), the closing date must be before settlement date (or the day of).

Investors Feel They Pay for Short Sellers Gains

Naked short-selling has been a hotly debated issue amongst Canadian retail investors. From our view, many retail investors feel they aren’t fully supporting a company’s future when they buy shares in the open market, instead, they are supporting a wealth transfer mechanism that includes various Bay Street Investment Banks and Predatory Hedge Funds.

Law Firm McMillan LLP wrote a blog post back in 2019 analyzing the impact the lack of regulation has caused the Canadian Capital Markets, saying that Canada took a hands-off approach, while other countries got more active. They wrote, “From 2015 to 2018 there was an increase in the number of short campaigns in Canada, while generally in other jurisdictions there was a decrease. ” editor James Stafford wrote an editorial piece for Business Insider in 2021, highlighting the issues with naked short-selling. At the time, Stafford wrote, “Stocks are sent into a tailspin when shorters fail to settle a trade and cannot find any stock to buy back, meaning that there are more shares which seem to be outstanding than there really are on the market. It’s an existential crisis for companies targeted by naked shorters. While technically, traders only have two days to settle those shorts, they are often given 10 days under “exceptional circumstances”, according to CME.”

Whether or not this notice will have a profound impact on the Canadian Capital Markets remains to be seen. But hopefully, this clarification paves the way to make an example of those abusing the Canadian Junior Markets. Too often, it feels like funds with large balance sheets crush companies leaving founders, executives, employees, investors, and other stakeholders left holding a bag for a company that never got a fair chance. All so that a portfolio manager could add a few basis points to their performance. Let’s hope this is a step in the right direction.

For more information, we encourage investors to read the original IIROC notice or contact a licensed financial advisor.

Information for this briefing was found via IIROC. The author has no securities or affiliations related to this organization. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.

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